Thursday, December 24, 2009

Goldman's Abacus Deals, the New York Times' Today, Hawala and More

Janet Tavakoli emails:

The New York Times wrote an interesting article today about Goldman’s Abacus synthetic CDOs and the counterparties who may have been on the other side of some of the credit derivatives used to create them. This month’s Risk Professional published an excerpt of Chapter 6 of my book, Dear Mr. Buffett, “Beware of Geeks Bearing Grifts,” in which I explain the strategy. Goldman wasn’t alone in employing this strategy. The strategy can be employed by the deal structurers, hedge funds, other types of clients or any combination of the former.

For example, hedge fund managers that are also CDO managers buy protection (in the form of a credit default swap) from the CDO it manages, and then sells protection to the hedge funds that it also manages. Among other deals, I recap a Merrill deal called “Norma.” The Wall Street Journal’s Carrick Mollenkamp and Serena Ng wrote about it two years ago, in December 2007 (I helped with background and was quoted), and they questioned Magnetar’s strategy. A hedge fund does not have to manage a CDO to participate, but it is all the more egregious when it does.

I also recap all of the ABS CDOs of this type that Merrill brought to market in 2007. How could it happen Merrill got “stuck” with losses? That isn’t the right question. The question is how did it manage to get through a couple of bonus cycles without taking accounting losses while showing “profits?” The answer is CDO hawala.

In a control fraud, the agents, highly paid “professionals” prosper, but often financial institutions and their shareholders and debt holders suffer (debt holders were bailed out in our recent crisis, and they shouldn’t have been).

CDO hawala is similar to the complex, but highly effective, money brokering system used in the Middle East. Hawala makes it virtually impossible to trace cross border money flows. Suspect collateral was traded among mortgage units and structuring firms. This makes it hard for anyone, except someone with the authority or subpoena power to examine your trade tickets, to figure out what you are doing. The hedge funds profit mightily, which is “lovely” for the hedge fund manager, since it earns much higher fees from the hedge funds than from the CDOs.

In the second edition of Structured Finance (Wiley 2008), I provide even more details and suspect strategies.

Several people asked about Goldman’s Abacus 2005-2 CDO mentioned in the article below. It is a synthetic CDO, the first one ever managed by C-Bass. Much reviled Litton is the servicer. Goldman purchased Litton from C-Bass in 2007. Servicers are part of the process, since servicers can influence the disposition of the collateral of any mortgage security backed by mortgage assets, whether it is cash, synthetic, or a hybrid of both.

There should be fraud audits of the securitization units of several firms. The audit should encompass the relationships with mortgage lenders, servicers, hedge funds, SIVs, and more. A fraud audit doesn’t mean you are accusing anyone of fraud, only that the audit will be thorough enough to uncover it, if it exists.

No comments:

Post a Comment